Survey: Reduce employer stock in 401(k) plans

The study attributes the under-performance of the portfolios examined to the fact they have a “large cap tilt” and a market beta of less than one (1).

Businesses that allocate higher than average amounts of employer stock to 401(k) plans tend to underperform those of their peers the following year, both in terms of relative performance and on a risk-adjusted basis, new research reveals.

Morningstar Investment Managementdiscloses this finding in a report, “Employer Stock Ownership in 401(k) Plans and Subsequent Company Performance.” As a result of the findings, the paper argues against employees holding significant amounts of company stock.

The study attributes the underperformance of the portfolios examined to the fact they have a “large cap tilt” and a market beta of less than one (1). Translation: The portfolio’s stock generally moves in the same direction as, but less than the movement of, a particular benchmark, such as the S&P 500 index.

This contrasts with a beta of less than zero (preferred by asset managers seeking a well-diversified portfolio), signifying an asset that moves in the opposite direction of a market benchmark. Inverse exchanged-traded funds and short positions on stock are examples of investments with betas below zero.

“Even after correcting for these market factors and after including other risk premiums such as value, liquidity and momentum, we found this underperformance exists,” the report states. “These findings have implications for plan sponsor fiduciaries who allow participants to invest in employer stock in the 401(k) plan and those who are considering doing so in the future.”

The report also observes that employer stock is still common in 401(k) plans, but is becoming less so. And it notes the decline in assets allocated to employer stock with 401(k) plans has been accompanied by a decreasing availability of employer stock as an investment option.

The following chart shows the average full-period employer stock allocation as a percentage of total 401(k) plan assets by market capitalization group: